Standalone investment banks are headed for obsolescence and perhaps even extinction, said Ken Lewis, chairman, president and chief executive of Charlotte-based Bank of America in a Nov. 7 speech at the Wharton School. “It’s a bad public-company business model. It’s too volatile and too narrowly focused,” he said. “I don’t see how any of the investment banks will remain independent entities.”
As CEO of the nation’s second largest commercial bank, Lewis has reason to badmouth investment banks. They’re his competitors. With the 1999 repeal of Depression-era restrictions, commercial banks such as his were allowed, as investment banks are, to advise corporations on mergers and acquisitions and underwrite securities. Commercial banks – Lewis calls them “integrated banks” – were also permitted to buy investment banks. Bank of America bought Montgomery Securities. “All the technology bankers walked out on us, which, as it turned out, was great luck.”
Jokes and jabs aside, Lewis’s remarks point to a philosophical debate about the future of financial services: Will the industry be dominated by a few big players such as Bank of America and New York-based Citigroup that can offer every sort of financial service or will smaller companies continue to thrive?
“Our thesis is we’re seeing a fundamental shift in the business model. To win in the market, players will have to provide financial and intellectual capital through a single relationship. The share of investment banking fees earned by U.S. integrated banks has increased 24% since 1999, while the share earned by pure-play investment banks has dropped more than 17%.”
Lewis said the technology bubble in the stock market during the late 1990s was akin to a graduation bash for investment banks, a bacchanal before they had to confront a tough future. And the excesses of that time leave them ill-prepared for the slog ahead. “There are too many investment banks chasing too few deals, and their infrastructures are too large to profitably serve the base of deals that’s there.
“In the past, the investment banking business gave you great returns on equity. But we think that’s no longer the case. And we don’t think the capital markets will come back next year and maybe not even the year after that. When they finally do, they will not be anywhere near the levels that they were during the tech bubble.”
Investment bankers counter that they remain capable of competing as long as the commercial bankers play fair. And they say the commercial banks aren’t. They have accused them of saying to companies, in effect, if you want loans, you have to let us underwrite your stock offerings. Called tying, this practice is prohibited by the Bank Holding Company Act of 1970.
Lewis’s response: We’re guilty, up to a point. “I have promised not to use words like sniveling and whining, but our position is tying can be illegal, and we don’t condone illegal tying. If we found a case inside our company, there would be dire consequences for those involved.
“But the law doesn’t prohibit us from being interested in the profitability of our company. Like any company, we routinely review the profitability of all our corporate relationships. When we find one that falls below our profitability thresholds, we work with the client to restructure it. We don’t dictate the answer. We simply say, ‘Here’s the rate of return our investors expect. Help us get there.'”
Asked if his bank would consider buying a big investment bank, Lewis responded, “I’m highly skeptical that I’ll ever think an investment bank is worth what it thinks it’s worth.” Plus, for Bank of America to do such a deal, the two companies’ cultures would have to dovetail. “Our culture can’t change. It has to be our values. We wouldn’t tolerate a taint on our culture or a subculture.”
And typically, he said, investment bankers value different things than commercial bankers do. They stress revenues over profits and view themselves as an elite corps entitled to better pay than other employees. “Should I think investment banking is elite when our consumer bank is earning 25% returns,” compared with 15% to 18% for the average investment bank, he asked.
Lewis said he’s more interested in doing a retail-bank acquisition in Mexico. Bank of America already has a hefty presence in Texas and California. “Seventy percent of Hispanics who have a bank account in California have it with Bank of America,” he said. And the bank is focusing on those regions for further growth. During the first week of November, it trumpeted plans to open 550 new branches in such cities as Los Angeles, San Diego, Fort Worth and Houston, among others.
Under Lewis, Bank of America’s strategy has changed from that of a company that focused on growth, costs be damned, to one that focuses on profitability. His predecessor, Hugh McColl, loved doing deals, gloried in his brief career in the U.S. Marine Corps and kept a crystal hand grenade on his desk. And McColl transformed what was once a bank little-known outside of North Carolina into a nationwide company. He accomplished that by doing acquisition after acquisition, culminating with the 1998 merger of what was then called NationsBank with San Francisco-based BankAmerica Corp.
Lewis, a 55-year-old Mississippi native, replaced McColl in 2001. He had worked at the bank since graduating from Georgia State University in 1969 and was largely unknown outside it when he took over.
With him as boss, Bank of America’s stock has performed well, despite a tough market. Over the last two years, it has returned more than 40%, compared with a 35% loss for the Dow Jones Total Stock Market Index. The company’s earnings, too, have been steady, while those of some financial-services companies have faltered.
It reported net income for the third quarter, which ended Sept. 30, of $2.24 billion, or $1.45 per diluted share, compared with $841 million, or 51 cents a share, a year ago. The bank’s return on equity – a key measure of profitability – was 19% for the most recent quarter, up from 6.8% a year ago.
Earnings for the third quarter in 2001 were hurt by a one-time charge of $1.25 billion, and earnings for the third quarter of 2002 were boosted by a change in accounting rules that let the bank stop amortizing goodwill. Take away the charge and the accounting change, and net income would have been nearly flat, and earnings per share would have risen by 6%. Revenue for the most recent quarter was $8.5 billion, down slightly from $8.6 billion for the comparable quarter a year ago.
While focusing on improving Bank of America’s numbers, Lewis has eschewed the mega-deals that marked McColl’s tenure. “For 30 years, we’d said it was a strategic imperative to become a coast-to-coast bank. When we did that, we couldn’t hide behind it anymore & Simply put, we’ve had to go from being a company that acquired customers by acquisition to one that gets customers one at a time.”
